Too Good To Be True

By Adam Zagorin

Many U.S. executives savored fat bonuses last month after their companies pulled in record sales and profits. But not Lawrence Coss, the chief executive officer of mobile-home lender Green Tree Financial, who in 1996 surprisingly topped the list of highest-paid corporate leaders--overshadowing such titans as the Travelers Group's Sanford Weill and Walt Disney's Michael Eisner. Whoops! To his dismay, Coss may have to repay $40 million of the $102 million bonus he received that year because Green Tree now concedes that accounting errors led it to overstate profits. Says the taciturn and reclusive Coss of the financial revision, which included nearly $400 million of previously unreported losses: "It is certainly disappointing."

And how. But it was also hardly uncommon in an industry that had been white hot until recently. As a so-called sub-prime lender, Green Tree makes high-interest loans to people with damaged credit. With dozens of rivals streaming into the field, however, profits and stock prices have been heading south faster than a recreational vehicle. Just last week the Money Store, for which Hall of Fame pitcher Jim Palmer delivers commercials, reportedly put itself up for sale after recording a dizzying slump in profits. Two other big lenders--Aames Financial and Cityscape Financial--are seeking buyers as well. "You've got too much competition chasing too few profitable loans," says Jeffrey Evanson, who follows the industry for the investment firm Piper Jaffray in Minneapolis, Minn.

Few shareholders have suffered more than those of Green Tree, which was founded in 1975 in St. Paul, Minn., and has long been an industry leader. Hapless Green Tree investors have seen their stock sink from $50 a share last October to just $19 before it rebounded a bit to close at $24 last week. Coss, 59, a former used-car salesman who sports jeans and cowboy boots off the job, has seen the value of his own shares fall from $330 million to $145 million. Such misery has plenty of company: more than 20 Green Tree competitors have lost anywhere from one-quarter to two-thirds of their market value in the past year. "A lot of companies got into very serious trouble very quickly," says James Allen, executive editor of Specialty Lender, an industry newsletter.

Yet with an estimated 30 million to 40 million potential customers who have few other places to turn for cash, sub-prime lenders have been Wall Street darlings. Borrowers whose chief alternatives ranged from pawnshops to loan sharks gladly jumped at the chance to pay nosebleed rates of 10% or more for a home-equity loan (vs. roughly 7% at a bank), if that was what it took to get money. Depending on points, fees, insurance and other charges, the effective interest on some sub-prime loans, particularly for autos, can top 30%.

Small wonder, then, that the industry zoomed from about 10 companies in 1994 to some 50 participants last year. Giants such as GE Capital, Norwest Financial and Ford's Associates First Capital came barreling in alongside lesser-known newcomers. But the overcrowded field swiftly became unforgiving. For example, the market value of Mercury Finance, a sub-prime auto lender in Lake Forest, Ill., collapsed from $2.2 billion to $130 million last year after the company disclosed that it had overstated profits.

Such lenders were unable to navigate the economy's rapid crosscurrents. Even as defaults eroded profits, the booming economy has allowed some sub-prime borrowers to pay off their loans ahead of schedule. That has reduced income and ruined profit projections in many parts of the industry. Notes Daniel Phillips, chairman of FirstPlus Financial, a Dallas sub-prime lender: "No matter how conservative a lender's assumptions are, no crystal ball allows him to see what may happen."

Just ask Green Tree, where many shareholders remain bitter about the profit revision, which included a $190 million write-down for the fourth quarter of 1997. Angry investors have filed at least a dozen lawsuits, some charging that Green Tree used improperly "aggressive" accounting methods to tot up profits and thereby boost Coss's personal pay--a charge the company denies. Coss did enjoy a formula that accorded him a salary of $400,000 plus 2.5% of the company's pretax profits. Half the compensation was in cash, the other half in the form of Green Tree stock that Coss was allowed to purchase for $3 share at a time when it was selling for more than 15 times as much on Wall Street.

Yet Green Tree seems likely to ride out its troubles. The company employs 5,700 people at 200 locations across the country and holds a whopping 30% of the lucrative market for financing mobile homes, making it the sector's largest lender. In addition, more than 90% of its $28 billion loan portfolio is secured by mobile homes, houses and other customer assets. Such backing is rare in the sub-prime industry and enables Green Tree to recover a relatively high proportion of losses when customers default on their payments. And despite problems such as the downgrading of much of Green Tree's debt by rating agencies, the company just declared its 46th straight quarterly dividend and expects to expand its loan portfolio to $32 billion this year.

Like other sub-prime lenders, Green Tree makes a business of bundling up loans and selling them as packages of asset-backed securities to pension funds and other big investors. That replenishes Green Tree's capital and lets the lender make fresh loans and thus pump up volume, which grew 39% in 1997.

Coss, who knew poverty firsthand as a child, is no stranger to financial setbacks. He quit school following eighth grade and failed as a car dealer before pulling himself out of bankruptcy and scraping together the funds to found Green Tree. Today he remains firmly in charge, particularly after the resignation of Green Tree president Robert Potts, who quit in December amid the furor over the income revisions. Not much given to displays of wealth, Coss maintains a vacation house in Flagstaff, Ariz., and likes to buy up land near his hometown of Miller, S.D.

For his mistakes Coss continues to pay a hefty price in the form of bonus givebacks and the drop in the value of his shares. And he is unlikely ever to regain his crown as America's top-paid executive, because Green Tree has changed its compensation formula to make it less generous. Despite the recent turmoil, though, Coss will take home a pay package worth about $4 million for his work last year.

As for the rest of the industry, it continues to face a painful shakeout. And fewer lenders could mean that rates for sub-prime borrowers will be heading higher. Even in prosperous times, this little-known corner of the financial world is likely to remain a risky business.